The economy

Pausing or plummeting?

UNCERTAINTY is not just the province of politics. America's economy is looking shakier than it has done for some time. Advance figures had suggested that the economy grew at an annualised rate of only 2.7% in the third quarter. Now that figure may be revised down to around 2%, a laggard's pace not seen since 1995, after this week's announcement of an unexpected 15% jump in the monthly trade deficit to a record $34.3 billion in September. Is this a temporary pause, the beginning of the much-vaunted soft landing—or something worse?

Most opinion on Wall Street favours a soft landing. Although many of the reasons for slow growth in the third quarter were one-offs (such as unusually weak government spending), the soft-landing camp sees signs of a more permanent slowing. In manufacturing, in particular, the evidence for weakness is clear. Factory output slipped 0.1% in October, weighed down by a 7.8% plunge in sales of motor vehicles and parts.

Looking ahead, the soft-landers presume that both investment and consumption will slow, in part because of weaker earnings and wobbly financial markets. This slowdown will keep inflation under control and interest rates steady, without risking a recession. Forecasts by the National Association for Business Economists, for instance, expect GDP growth of 3.4% in 2001, compared with 5.2% in 2000. They expect inflation to fall to 2.6% in 2001 while interest rates drop. Just over half of the NABE's forecasters reckon that the Federal Reserve's current level of short-term interest rates (6.5%) will be the peak for this economic cycle.

Others disagree. In its latest Economic Outlook, for instance, the OECD agrees that America's GDP growth will slow to 3.5% next year, but it also expects a further 0.5% rise in interest rates. In an unusually upbeat report, the OECD, long sceptical about the sustainability of America's boom, argues that the “long-standing risks to the [American] economy would seem to have become less serious in the short term”. Part of this optimism is due to the fact that the OECD's boffins have raised their estimates of America's sustainable rate of growth to 4%. Nonetheless, it is ironic that the OECD becomes more confident as other analysts grow more worried.

For some, there are signs that the landing may be rougher than expected. Earlier in 2000, initial jobless claims averaged 285,000 per week. In October they hit an average of 310, 000 per week; so far, their average in November has been 337,000. According to economists at J.P. Morgan, these jobless claims typically rise about 15% in slowdowns (in this case to about 325,000 on a sustained basis), but at least 35% in recessions (which would imply 385,000).

Others predict only a temporary pause. Gail Fosler, chief economist at the Conference Board, who recently won a prestigious forecasting award, barely sees any landing at all. Healthy, if marginally slower, growth means there will not be enough of a slowdown to defuse the pressure towards higher inflation.

And, despite the apparently benign 0.2% increase in October's consumer prices, there is plenty to worry about on the inflation front. In the service sector in particular, price pressure is clear. Next year, it seems likely that rising wages will bring more pressure either on firms' profits or on prices. In this environment, Ms Fosler thinks, the risks of over-correction (or a hard landing) are high. She expects short-term interest rates to reach 7.5% in 2001, and reckons that the economy will grow by only 1% in 2002. While that may not technically constitute a recession, it will certainly feel like one.

Other well-known Cassandras are equally pessimistic. Stephen Roach, chief economist at Morgan Stanley Dean Witter, for instance, sees a 40% probability of a hard landing in the first half of 2000, as a deceleration in the global economy combines with a destabilising jolt, such as an earnings or dollar shock. So far, it is too early to tell whether such pessimism is warranted or whether the majority's expectation of a soft landing will prove correct. Either way, it is clear that high, and ongoing, uncertainty is as bad for America's economy as it is for its politics.